Insurance mess may ignite bigger problems
moneycentral.msn.com
Contrarian Chronicles
Insurance mess may ignite bigger problems
The insurance scandal is another strong signal that our financial system is vulnerable to serious disruptions. The next 18 months could be dangerous ones.
By Bill Fleckenstein
When future historians look back on this period, with all its attendant dangers and warning lights flashing in neon, they will scratch their heads as to why everyone was so complacent and so supremely confident right before the financial hurricane hit.
Last July, I talked about the potential for a market dislocation in my column "Odds of a crash are higher than you think.” Once again, I want to reiterate that it's a low-probability event. But whatever the probabilities were when I laid them out a few months ago, they can only be higher now.
A watchdog smells a rat
Marsh & McLennan (MMC, news, msgs), the subject of a continuing investigation by New York Attorney General Eliot Spitzer, demonstrates the problem that could happen in many other arenas. As Gretchen Morgenson of The New York Times pointed out last Wednesday in "Investors Are Losing Ground As Insurance Inquiries Expand:"
"The pain of losing almost 50% in share value is perhaps most excruciating to the thousands of Marsh & McLennan employees who have bought Marsh stock. . . . There is a pension plan, a stock purchase plan, 401(k) accounts, stock option grants and a cash bonus deferral plan to name a few. And in all cases, Marsh stock or Putnam funds dominate the offerings. . . . According to Marsh filings, at the end of last year, a defined-contribution plan for Marsh & McLennan employees had assets of $2.24 billion. Almost 60% of the plan's assets were in Marsh stock -- $1.3 billion worth."
The eggs-in-one-basket aftermath
However, it won't be just MarshMac employees who will be affected. If any employees had thought they were wealthy because they held a lot of MarshMac stock, and if they used that wealth to buy expensive homes during the housing bubble, they'll be in trouble when the housing bubble starts to reverse along with their net worth. The banking industry could wind up with a lot of bad paper.
I'm not saying that events surrounding MarshMac will play out exactly this way. Down the road, though, I expect that we'll see dominoes fall in this manner on a large scale when the bear market really gets rolling in stocks (again) and housing. These two asset-class declines are going to feed on each other, and a whole lot of credit is going to be impaired.
Playing debt dominoes . . .
Though the financial industry has managed to remain unscathed (thanks, in no small part, to its absurd accounting), it too will get mauled if shenanigans are turned up and that impacts credit rates. Most of these financial companies have a good deal of debt, and it's held by other companies, both within and beyond the financial arena. So, the potential for this investigation to snowball is not trivial.
Of course, if you add a problem in the financial industry to problems in real estate and the stock market generically, you can see how we would be headed for a world of hurt. It's what happens when you pursue irresponsible, reckless policies for so long.
. . . and derivatives dominoes
The probability of a dislocation may also have increased due to the location of the ticking time bomb known as derivatives. American International Group (AIG, news, msgs), another target of Eliot Spitzer's investigation, is very active in the derivatives market. If the company -- one of the few AAA credits left in America -- has a problem of any magnitude that impacts their perceived credit quality or credibility, it would in all likelihood wreak havoc in the derivatives market. (As Warren Buffett said last July, "We have trillions of dollars of derivatives, of which we have no knowledge of how they might work in a market meltdown.")
Think about this from the perspective of foreigners. They now look at Fannie Mae (FNM, news, msgs), MarshMac, AIG and Merck (MRK, news, msgs) and observe a black cloud hanging over what have been deemed to be some of the best corporations in America. It's just another psychological negative for the dollar, in my opinion, and a reason for foreigners not to want to own our stocks. (Editor’s note: the euro is up 4% against the dollar in the last month.)
Trouble is so close you can taste it
Meanwhile, for the "professionals" who play with other people's money, the rally cry is: Buy stocks first and ask questions about fundamentals later. With a huge chunk of third-quarter earnings behind us, we're at the point in the quarter when the bulls typically like to throw a party. They figure there's no more bad news in the offing, and in the absence of bad news, stocks should always go up. Over the next couple weeks, I'm sure that the bulls will attempt to rally the market whenever they can.
They may be able to party a bit longer, but big trouble seems so close, you can almost taste it. Once we get past the election and its attendant noise, attention will be turned to the fourth quarter and, more importantly, 2005. By my reckoning, the next 18 months look to be one of the most dangerous periods for financial markets in the last 50 years. The destruction of capital measured in the trillions lies ahead in the not-too-distant future.
|
